How Elvira Nabiullina Can Improve Russia’s Central Bank

Russia’s central bank is about to
get a new chairman and, as at the Bank of England, the imminent
arrival of a new broom has raised expectations of a more relaxed
monetary policy.

Russia, however, is different. Elvira Nabiullina will be in
a position that many central-bank chiefs can only envy because
she will have ample room to boost lending and growth, using
conventional tools. The central bank’s crucial lending rate is
8.25 percent, compared with the near-zero rates in the U.K., the
U.S. and the euro area.

A second difference is that Nabiullina will take over the
Central Bank of Russia in June at a moment when Russia’s economy
is at a pivotal point. The bank’s new leader needs a much wider
focus to head off serious risks. As well as keeping interest
rates down, she needs policies that will keep Basel III rules
out and investments in.

Many observers of the Russian economy have been arguing
that the central bank has kept monetary policy too tight for too
long. The outgoing chairman, Sergey Ignatiev, repeatedly pointed
to high inflation risks and unemployment as low as 5 percent as
the two main obstacles to any easing. Those hurdles are
diminishing.

Recession Warning

Inflation slowed in March, unemployment is up to 5.7
percent and leading indicators of future growth rates -- such as
retail sales, industrial production and economic confidence --
point to a decline. Nabiullina’s successor as economy minister,
Andrei Belousov, gave a stark warning this month that Russia
faces a possible recession this year.

I believe the central bank will need to cut interest rates
by 0.75 percentage point in response. With inflation and
economic growth both slowing, the question is when, not if, this
will happen.

But a more accommodative monetary policy has limits. In the
U.S., for example, securing sustainable economic growth has
proved difficult, despite all of the Federal Reserve’s efforts.
So Nabiullina should use other tools at her disposal.

A good start would be to redefine the central bank’s
refinancing strategy. This can’t mimic the European Central
Bank’s open-market operations because Russia’s tiny national
bond market increases the risk of collateral shortage in the
banking system. In 2012, collateral utilization -- the
proportion of total collateral in the market that is being used
for central-bank refinancing operations -- was about 50 percent
in Russia, compared with about 20 percent across the euro area.
A potential collateral drought is a long-term challenge in
Europe. In Russia, it is already putting pressure on the money
markets.

Russia’s central bank should borrow a different tool from
the ECB’s kit, providing liquidity to banks through long-term
refinancing operations. Combined with a rate cut, this would
help to boost domestic lending and reduce the exposure of
Russian companies to foreign-currency refinancing risks. High
domestic interest rates make businesses seek financing abroad.
As of January, Russian corporations had $564 billion of foreign
debt, or about 30 percent of gross domestic product. That’s
almost a third more than in January 2008.

Nabiullina will also have to make decisions on the
introduction of the Basel III banking-regulatory regime and on
improving Russia’s financial-market infrastructure. The central
bank shouldn’t be in a hurry to introduce Basel III, at least
this year, for two main reasons.

Limited Funding

First, Basel III focuses on increasing the size and quality
of capital reserves, both of which are crucial to the effective
and safe operation of the financial system. Yet given the
limited availability of funding sources in Russia today, this
could also lead to a reduction in lending to the real economy.
Some banks may struggle to raise the extra capital needed at a
time when market conditions are tough.

Second, Basel III should be evenly adopted across all
jurisdictions to avoid the risk of regulatory imbalances. Given
that programs to introduce the new Basel III rules have stalled
in the U.S. and the European Union, they should be delayed in
Russia, too.

That brings us to the investment climate. The government
has already committed to spend 400 billion rubles ($13 billion)
on infrastructure projects in 2013, as a form of fiscal
stimulus. Nabiullina can also play a role in improving the
climate for domestic and foreign investment, once Russia’s
financial-markets regulator starts merging with the central bank
in August.

Given the current shortage of liquidity and collateral, a
good starting point for Nabiullina would be to develop Russia’s
market for securitized debt. Today Russia only has a market for
trading securitized-mortgage loans. This should be expanded to
include a wide range of assets, including consumer debt and
loans to small and medium-size companies.

Nabiullina is well-prepared to take on these challenges.
She helped as an academic to draw up Russia’s reform program in
the 2000s, and she was economy minister from 2007 to 2012, a
difficult period. She has an exceptional understanding of the
broader macroeconomic picture and of the pivotal role that the
central bank plays. The opportunity is there for her to seize.

(Andrey Kostin is chairman of VTB Group, Russia’s second-
largest lender. He is also chairman of the B20 financial-
stability task force. The opinions expressed are his own.)

To contact the writer of this article:
Andrey Kostin at e.litovchenko@vtb.ru.